Chapter 12—Financial Statement Analysis Key
1. Comparing two companies in the same industry should cause no problem since both companies are required
to use the same accounting principles.
2. Time series analysis compares a company’s financial data with industry averages.
3. Along with its other financial statements, a public corporation must present its most recent two years of
income statements within Item I of its Form 10-K.
4. Management’s Discussion and Analysis is a key part of the 10-K because it provides investors with
information management believes necessary to understand the company and forecast future performance.
5. The analysis of common size financial statements may be included in a horizontal or vertical analysis.
6. An example of vertical analysis is that the cost of goods sold for 2015 is 129% of the amount from 2014.
7. An increase in a company’s revenue and expense accounts will always cause an increase in net income for the
period.
8. Common size financial statements exclude the dollar amount as a relevant variable in the analysis, which
makes comparison of one period with the next more meaningful.
9. When using vertical analysis of the income statement, the base upon which all items are compared is net
income.
10. The net profit margin percentage reflects the amount of income for each dollar of sales.
11. Three measures of liquidity include working capital, the acid test ratio, and the current ratio.
12. Inventory is more liquid than accounts receivable because receivables must be collected and some
customers may not be willing to pay, while inventory need only be sold in a retail store.
13. The length of the operating cycle is always considered to be a one year period, although that one year
doesn’t have to begin on January 1.
14. The return on equity ratio measures the profit earned by a company through the use of capital supplied by its
bondholders.
15. Return on assets is computed by adding the after-tax interest expense to net income, then dividing by the
average total assets.
16. The stock repurchase payout ratio is calculated by adding the dividend payout ratio to the total payout ratio.
17. The least liquid of all assets is cash.
18. The amount of working capital is more meaningful to users than the current ratio because working capital
provides information on the composition of the current accounts.
19. The acid test ratio is a stricter measure than the current ratio regarding a company’s ability to pay its current
obligations as they are due.
20. Ratios that focus on cash are more useful than those that focus on income in the evaluation of a company’s
liquidity.
21. Riverdale Drugs has an inventory turnover ratio of 15 times while RJ’s Drugs has an inventory turnover of
14 times. RJ’s is less efficient in managing its inventory.
22. Liquidity refers to a company’s ability to pay its current obligations when they come due.
23. The best source of information about a particular company is Standard & Poor’s industry guide.
24. Many companies assist the users of the financial statements by providing information about the company’s
accounting policy choices in the first note to the financial statements.
25. A company with a capital structure that shifts more toward debt financing will appear to be in a stronger
position to pay interest and any principal amount that may be maturing by using its cash flows generated by
operating activities.
26. As a general rule, all users of financial statements seek answers to the same questions.
27. When trying to predict future profits, analysts often take a top-down approach which starts with gathering
economic and industry data to supplement what they are able to find out about the specific corporations they
follow.
28. Form 8-K is the “current report” companies must file with the SEC to announce major events that are
important to investors and creditors.
29. A company that is considering selling goods or providing services to another company wants to know
whether its customer will provide: competitive salary and benefits; experiences that will prepare employees to
assume increased responsibility; and a secure job for the foreseeable future.
30. Investors who buy stock in a corporation expect to earn returns on their investment from dividends and an
increase in the value of the stock (a capital gain).
31. Trend analysis is another name for ____________________ analysis.
32. The three aspects of return on equity (ROE) recognized by DuPont analysis are the net profit margin
percentage, the ____________________ ratio, and leverage.
33. Public companies file their annual reports on Form ____________________.
34. Public companies file their quarterly reports on Form ____________________.
35. ____________________ analysis compares one corporation to another corporation and to industry
averages.
36. ____________________ analysis compares a single corporation across time.
37. ____________________ statements highlight differences by expressing each financial statement item in
percentage terms.
38. In ____________________ analysis, each financial statement line item is expressed as a percent of a base
year, which is typically the earliest year shown.
39. In ____________________ analysis, each financial statement line item is expressed as a percent of the
largest amount on the statement, which is net sales for the income statement and total assets for balance sheet.
40. ____________________ refers to the likelihood that a company will be able to pay its current obligations as
they come due.
41. ____________________ assets generally include cash, accounts receivable, and short-term investments.
42. A company’s relative mix of debt and equity financing is referred to as its __________ structure.
43. Measures of ____________________ evaluate how efficiently a company uses its assets, that is, the average
length of time required for assets to be consumed or replaced.
44. Various financial ratios, including payout ratios, are categorized as ____________________ ratios.
45. Various financial ratios, including return ratios, are categorized as ____________________ ratios.
46. For each of the following sentences, select the phrase or group of words that best completes the statement.
return for all providers of capital.
8
1. Measure of a company’s success in earning a
1
2. Relationship between dividends and the market
payout.
2
3. Difference between total payout and dividend
basis.
7
4. A company’s bottom line stated on a per share
Return on common
stockholders’ equity.
4
5. Relationship between total liabilities and
return.
5
6. Using debt to help the company earn a higher
return for the common stockholders.
6
7. Measure of a company’s success in earning a
8. Percentage of earnings paid out as dividends.
3
Stock repurchase
47. Select the ratio that each definition most properly satisfies.
company to make its interest payments.
5
1. An income statement measure of the ability of a
Return on common
price of a company’s stock.
4
2. The relationship between dividends and the market
current obligations from cash from operations.
2
3. A measure of the ability of a company to finance
4. The relationship between net sales and total assets.
Times interest
earned ratio
1
return for the common stockholders.
3
5. A measure of a company’s success in earning a
Operating cash flow
48. Match the term with its correct definition.
1. Form that represents the company’s annual report by providing
a comprehensive overview of the corporation’s business and
Form 10-
2. Form that includes unaudited financial statements and
provides a continuing view of the corporation’s financial position
during the year since it must be filed for each of the first three
3. Form that companies must file with the SEC to announce
4. Forms that companies must file with the SEC to “register”
Form 10-
5. In this section of the annual report, management discusses its
views of the financial condition and performance of the
Forms S1
49. Match these terms to their correct definition.
1. each financial statement line item is expressed as a
percent of the base year (typically the least recent year
Time series
2. provides analysts with a wealth of information to
evaluate such things as the corporation’s profitability,
4. express each financial statement line item in percentage
terms in order to highlight differences. Typically, this
conversion from dollar amounts to percentages is done
Horizontal
5. compares a corporation’s financial statements to its
6. assess the likelihood that a company will be able to pay
Common size
7. decomposes the return on equity ratio into margin,
Short-term
8. each financial statement line item is expressed as a
percentage of the largest statement amount, for example,
Cross-sectional
50. Match these terms to their correct definition.
1. Length of time required to collect the receivable from
2. Measures the proportion of each sales dollar that is
Accounts
receivable turnover
3. An even more conservative short-term liquidity ratio
Operating margin
4. Sum of the dividend payout and stock repurchase
5. Measures the profitability of a company’s operations
Inventory turnover
6. Measurement of the proportion of each sales dollar
7. Measure of liquidity that excludes assets that are
Net profit margin
8. Length of time required to sell inventory to
Gross profit
51. When an investor is evaluating whether to purchase stock in a company, which of the following
considerations is most important?
52. The working capital of a company is equal to
53. In evaluating a company’s financial statements, the least useful information would be derived from a
comparison of the current period data with
54. A banker is analyzing a company which operates in the automotive industry. Which of the following will
likely be the banker’s most important consideration in determining whether the company should receive a loan?
55. A financial analyst is comparing two companies using a top-down approach. Which of the following would
cause problems in the evaluation process?
56. Which of the following would report the market price of the company’s stock?
57. Annual reports are filed with the SEC on
58. The auditor’s opinions regarding effectiveness of a public company’s internal controls and appropriateness
of its financial statements are found within the Form 10-K on
59. Each of the following is included in the MD&A section of a public company’s Form 10-K except:
60. Form 10-K for a public company is required to include the following financial statements for the most
recent period of time including:
Income Statements and
Statement of Cash Flows Balance Sheets
61. Horizontal analysis is analysis in which
62. Time series (or trend) analysis is analysis in which
63. When a financial analyst determines the percentage change in operating income for the five-year period
from 2011 to 2015, she is performing a
64. Which of the following statements is true regarding horizontal analysis?
65. Rags to Riches
Selected data from the financial statements are provided below:
2015
2014
Accounts Receivable
$ 120,000
$ 76,000
Inventory
24,000
32,000
Total Assets
900,000
760,000
Net Sales
760,000
540,000
Cost of Goods Sold
320,000
420,000
Refer to Rags to Riches. Which of the following would result from a horizontal analysis of the company’s balance sheet?
66. Rags to Riches
Selected data from the financial statements are provided below:
2015
2014
Accounts Receivable
$ 120,000
$ 76,000
Inventory
24,000
32,000
Total Assets
900,000
760,000
Net Sales
760,000
540,000
Cost of Goods Sold
320,000
420,000
Refer to Rags to Riches. Which of the following would result from a horizontal analysis of the company’s income statement?
67. Rags to Riches
Selected data from the financial statements are provided below:
2015
2014
Accounts Receivable
$ 120,000
$ 76,000
Inventory
24,000
32,000
Total Assets
900,000
760,000
Net Sales
760,000
540,000
Cost of Goods Sold
320,000
420,000
Refer to Rags to Riches. Which of the following would result from a horizontal analysis of the company’s income statement?
68. Rags to Riches
Selected data from the financial statements are provided below:
2015
2014
Accounts Receivable
$ 120,000
$ 76,000
Inventory
24,000
32,000
Total Assets
900,000
760,000
Net Sales
760,000
540,000
Cost of Goods Sold
320,000
420,000
Refer to Rags to Riches. Which of the following would result from a vertical analysis of the company’s income statement?
69. Rags to Riches
Selected data from the financial statements are provided below:
2015
2014
Accounts Receivable
$ 120,000
$ 76,000
Inventory
24,000
32,000
Total Assets
900,000
760,000
Net Sales
760,000
540,000
Cost of Goods Sold
320,000
420,000
Refer to Rags to Riches. Which of the following would be found through ratio analysis of the company’s financial statements?
70. Which of the following statements is true regarding vertical analysis?
71. Which of the following profitability ratios would be determined through a common size vertical analysis of
the income statement?
72. The gross profit percentage decreased from 36.5% in 2014 to 24.8% in 2015. What is the trend in this
change?
73. In a common size income statement to be used in vertical analysis, the 100% amount is
74. In a common size balance sheet to be used in vertical analysis, the 100% amount is
75. Which of the following is considered a measure of short-term liquidity?
76. Which of the following ratios is least useful in evaluating a company’s ability to pay its current obligations
when they come due?
77. Which of the following is a measure of liquidity?
78. Rainsoft Company
Selected data from the financial statements are provided below:
2015
2014
2013
Cash
$ 44,000
$ 28,000
$ 14,000
Accounts Receivable
84,000
32,000
114,400
Inventory
44,000
166,000
100,000
Prepaid Expenses
46,000
36,000
41,600
Total Current Assets
$218,000
$262,000
$270,000
Total Current Liabilities
$130,000
$144,000
Net Credit Sales
442,000
652,000
Cost of Goods Sold
336,000
598,000
Net Cash Flows from Operating Activities
32,000
58,000
Refer to Rainsoft Company. What is the current ratio for 2015?
79. Rainsoft Company
Selected data from the financial statements are provided below:
2015
2014
2013
Cash
$ 44,000
$ 28,000
$ 14,000
Accounts Receivable
84,000
32,000
114,400
Inventory
44,000
166,000
100,000
Prepaid Expenses
46,000
36,000
41,600
Total Current Assets
$218,000
$262,000
$270,000
Total Current Liabilities
$130,000
$144,000
Net Credit Sales
442,000
652,000
Cost of Goods Sold
336,000
598,000
Net Cash Flows from Operating Activities
32,000
58,000
Refer to Rainsoft Company. What is the operating cash flow ratio for 2015?
80. Rainsoft Company
Selected data from the financial statements are provided below:
2015
2014
2013
Cash
$ 44,000
$ 28,000
$ 14,000
Accounts Receivable
84,000
32,000
114,400
Inventory
44,000
166,000
100,000
Prepaid Expenses
46,000
36,000
41,600
Total Current Assets
$218,000
$262,000
$270,000
Total Current Liabilities
$130,000
$144,000
Net Credit Sales
442,000
652,000
Cost of Goods Sold
336,000
598,000
Net Cash Flows from Operating Activities
32,000
58,000
Refer to Rainsoft Company. Which of the following statements is true regarding the company’s liquidity?
81. Rainsoft Company
Selected data from the financial statements are provided below:
2015
2014
2013
Cash
$ 44,000
$ 28,000
$ 14,000
Accounts Receivable
84,000
32,000
114,400
Inventory
44,000
166,000
100,000
Prepaid Expenses
46,000
36,000
41,600
Total Current Assets
$218,000
$262,000
$270,000
Total Current Liabilities
$130,000
$144,000
Net Credit Sales
442,000
652,000
Cost of Goods Sold
336,000
598,000
Net Cash Flows from Operating Activities
32,000
58,000
Refer to Rainsoft Company. Assume that competitors in the industry have an average accounts receivable turnover ratio of 7.8 times in 2015. What
is the company’s accounts receivable turnover ratio for 2015?
82. Rainsoft Company
Selected data from the financial statements are provided below:
2015
2014
2013
Cash
$ 44,000
$ 28,000
$ 14,000
Accounts Receivable
84,000
32,000
114,400
Inventory
44,000
166,000
100,000
Prepaid Expenses
46,000
36,000
41,600
Total Current Assets
$218,000
$262,000
$270,000
Total Current Liabilities
$130,000
$144,000
Net Credit Sales
442,000
652,000
Cost of Goods Sold
336,000
598,000
Net Cash Flows from Operating Activities
32,000
58,000
Refer to Rainsoft Company. Assume that competitors in the industry have an average inventory turnover ratio of 20.8 times in 2015. Rainsoft’s
inventory turnover ratio for 2015 indicates that the company
83. Liquidity analysis is required to
84. Which of the following is an example of liquidity analysis?
85. Which of the following results is generally considered favorable?
86. Which of the following would be generally viewed as a negative change?
87. Inventory turned over seven times during the year at Rockdale Electronics. Similar electronics retailers have
an inventory turnover equal to twelve times per year. Which of the following best explains the state of
Rockdale’s inventory management?
88. A company reported the following amounts in its financial statements:
2015
2014
Average inventory
$ 100,000
$ 60,000
Cost of goods sold
2,000,000
1,500,000
From 2014 to 2015, the company’s efficiency in managing inventory was
89. The quick ratio
90. The current assets of Rock Garden Gifts were considered very liquid at December 31, 2015. This means that
the company
91. Most companies
92. The quick ratio differs from the current ratio in that it
93. Turnover ratios differ from the current and quick ratios in that they
94. The operating cycle of a retail company is the length of time between the
95. The inventory turnover ratio is represented by which of the following formulas?
96. Which of the following ratios is used to analyze a company’s asset efficiency?
97. If a company’s current ratio is 1.5 and the current liabilities are $150,000, then the current assets are
98. Which of the following statements is true regarding the relationship of the current ratio and the acid test
ratio?
99. Assume that a company’s current ratio is 2.0. If the company purchases inventory on credit, which of the
following is true?
100. Which of the following will decrease the quick ratio?